‘The Statutory Charge’ armours the EPF dues supremacy over the lien of Creditors
By Chidambaram Ramesh
(Author of the book “The Law of Employees’ Provident Funds: A Case-Law Perspective“.)
In bankruptcy, the dispute between debtor and creditors is effectively transformed into one between the competing creditors of a common debtor. If there are many competitors to compete, who gets paid first? This is a question of priority. Usually, a secured creditor will rank first in the queue, whereas an unsecured creditor will usually be the last, with very little, if any, the chance of recovery. Among the unsecured creditors, there is no inherent priority. Instead, they are paid on the first-come-first-served basis, or they rush to the courthouse to get a favourable order. Unlike an unsecured creditor, a secured creditor has a lien on the collateral property of the debtor. A lien gives the secured creditor special rights only as to the collateral and not as to the rest of the debtor’s assets. There can be multiple liens on the same property also. When there is more than one secured creditor, and the liquidation estate is too less to pay them all, then the priority question among the secured creditors arise. To safeguard the interests of ‘statutory creditors,’ there are various forms of security which do not depend on the agreement of parties but are created by operation of law in given situations. Creation of statutory charge is one of such mechanism which operates by law.
First Charge Clause in the EPF Act
Taking into consideration the importance of the timely recovery of the Provident Fund arrears, the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 was amended in the year 1973 to incorporate a sub-clause specifying that every amount owed by an employer in respect of the employee’s contribution is considered to be the ‘first charge‘ on the establishment’s assets and is payable in preference to all other debts. The 1988 amendment to the EPF Act broadened Section 11(2)’s connotation by including the employer’s share of contributions also within the priority provision.
Section 11(2) of the EPF and MP Act contains a non-obstante clause laying down that if any amount is due from an employer whether in respect of the employees’ contribution deducted from the wages of the employees or the employer’s contribution, the same shall be deemed to be the first charge on the assets of the establishment and shall, notwithstanding anything contained in any other law for the time being in force, be paid in priority to all other debts. To put it differently, sub-section (2) of section 11 of the EPF and MP Act, as it stands now, has two facets. First, it declares the amount due from the employer shall be deemed to be the ‘first charge‘ on the assets of the establishment. Second, it also claims that notwithstanding anything contained in any other law for the time being in force, such debt shall be paid in priority to all other debts.[i] This double armour of power has always facilitated the recovery of provident fund arrears more effectively than the recovery of arrears in any other act. These provisions act as legendary Karna’s Kavacha Kundalam – the protective set of armour and earrings to safeguard the social security interest of the working class.
Prioritising the dues payable to Banks and Financial Institutions
Sweeping changes were also made to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) and the Recovery of Debts due to Banks and Financial Institutions Act, 1993 (RDDBI Act) by the Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016. The amendments were aimed at faster recovery and resolution of bad debts by banks and financial institutions. The amendment Act of 2016 introduced Section 26-E of the SARFAESI Act and Section 31-B of the RDDBI Act, 1993.
Section 26-E of the SARFAESI Act reads,
“26-E. Priority to secured creditors.- Notwithstanding anything contained in any other law for the time being in force, after the registration of secured interest, the debts due to any Secured Creditor shall be paid in priority over all other debts and all revenues, taxes, cesses and other rates payable to the Central Government or State Government or local authority.
Explanation.– For the purposes of this section, it is hereby clarified that on or after the commencement of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), in cases where insolvency or bankruptcy proceedings are pending in respect of secured assets of the borrower, priority to secured creditors in payment of debt shall be subject to the provisions of that Code.”
The RDDBI Act 1993, also through section 31-B, contains a similar clause.
“31B. Priority to secured creditors.- Notwithstanding anything contained in any other law for the time being in force, the rights of secured creditors to realise secured debts due and payable to them by sale of assets over which security interest is created, shall have priority and shall be paid in priority over all other debts and Government dues including revenues, taxes, cesses and rates due to the Central Government, State Government or local authority.
Explanation.- For the purposes of this section, it is hereby clarified that on or after the commencement of the Insolvency and Bankruptcy Code, 2016 (31 of 2016), in cases where insolvency or bankruptcy proceedings are pending in respect of secured assets of the borrower, priority to secured creditors in payment of debt shall be subject to the provisions of that Code.”
There is thus statutory recognition of priority claim of the secured creditors because of the amendment brought into effect under Act No.44 of 2016. By insertion of these non-obstante clauses, the secured creditors have been given priority over all other debts and revenues, dues, taxes, cesses and other rates payable to the Central or the State Government or local authority. But the larger question is whether the non-obstante clause inserted in the SARFAESI Act and the RDDBI Act can have the effect of overriding the ‘first charge’ clause provided under Section 11(2) of the EPF and MP Act 1952. Two points are crucial for consideration here. One, the dues payable by the defaulters under the Employees’ Provident Funds and Miscellaneous Provisions Act are not ‘government dues.’ Second is that there is no equivalent clause in any of these acts under which the ‘first charge’ is created in favour of the banks, financial institutions, or secured creditors over the property of the borrower. In other words, the ‘priority-over-all-other-dues’ clause is different from the ‘statutory first charge’ clause. The banks and financial institutions cannot claim ‘first charge’ despite having created a mortgage over the immovable property belonging to the borrower, for want of an enabling provision. The priority available at present to the secured creditor under the amended provisions of Section 31-B of the Recovery of Debts Due to Banks and Financial Institutions Act applies only to Government dues, and not to statutory dues payable under the EPF and MP Act, 1952.
In Indian Overseas Bank v Employees’ Provident Fund Organisation and others,[ii] the Gujarat High Court held that the inclusion of Section 31-B in the RDDBI Act does not change the position insofar as the priority of claim under the provisions of the EPF Act is concerned. The mention of Government dues which would include revenues, taxes, cesses and rates due to the Central Government, State Government, or local authority would not take into its fold the first charge created by operation of law in the form of Section 11(2) of the EPF Act. The ratio of this decision was followed in the case of International Asset Reconstruction Company Private Ltd. V Official Liquidator of Jupiter Cement India Ltd.[iii]
In Provident Fund Commissioner v Dena Bank and others,[iv] (a case which relates to the pre-amendment period, but the observations of the court assume importance in the post-amendment scenario also), the Gujarat High Court considered the priority of EPF dues over those payable to the secured creditors. Citing the decision of the Supreme Court in the case of Central Bank of India v State of Kerala and others, the Gujarat High Court held that the ‘overriding provisions’ comes into play only in case of any repugnancy between the legislations. When the EPF Act has the ‘first charge’ clause, and there is no equivalent clause in the banking recovery acts, there can be no repugnancy, and the application of the overriding clause does not arise. While enacting the DRT Act and Securitisation Act, the Parliament was aware of the law laid down by the Supreme Court wherein the priority of the State dues was recognised. If the Parliament had intended to create the first charge in favour of banks, financial institutions or other secured creditors on the property of the borrower, then it would have incorporated a provision like Section 11(2) of the EPF Act and ensured that notwithstanding series judicial pronouncements, dues of banks, financial institutions and other secured creditors should have priority over the State’s statutory first charge in the matter of recovery of the dues of sales tax, etc.
Thus, even after inclusion of Section 26-B and Section 31-B to the SARFAESI Act and RDDBI Act respectively, there is no provision by which ‘first chare’ is created in favour of the banks qua the property of the borrower. In contrast, Section 11(2) of the EPF Act makes ‘first charge’ on the assets of the defaulter. The non-inclusion of ‘first charge’ clause in the banking recovery laws have been intentionally done by the Parliament to safeguard the social security interest of the working class in case of conflict of interest between the various stakeholders over the limited property of the bankrupt. In Employees’ Provident Fund Commissioner v OL of Esskay Pharmaceuticals Limited,[v] where there was a conflict between two central legislations viz., the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 and the Companies Act, 1956, the Supreme Court observed that the EPF Act, being social legislation formulated for the welfare of the employees, will prevail over the inconsistent provisions on the priority of claims in the Companies Act, 1956, a subsequent legislation.
Charge vis-à-vis Mortgage
There is always a distinction between a ‘charge‘ and a ‘mortgage.’ Section 58 of the Transfer of Property Act defines, “a mortgage is the transfer of an interest in specific immovable property.” The term ‘charge‘ is defined under Section 100 of the Transfer of Property Act, 1882, “where the immovable property of one person is by an act of parties or operation of law made security for the payment of money to another, and the transaction does not amount to a mortgage, the latter person is said to have a charge on the property; and all the provisions hereinbefore contained which apply to a simple mortgage shall, so far as may be, apply to such charge.” There are two kinds of charges viz., charge created by the parties by consent and charge arising by operation of law. The charge created by operation of law is commonly called ‘statutory charge’ – which occurs irrespective of the consent of the parties. Thus, a charge is a broader term than a mortgage. It would cover within its ambit a mortgage also. When a first charge is created by operation of law over any property, that charge will have precedence over an existing mortgage.
In State Bank of Bikaner and Jaipur v National Iron and Steel Rolling Corporation,[vi] the State Bank had given a cash credit facility to a borrower who had created a Deed of Mortgage on his factory. The bank filed a suit for the recovery of its dues. At this stage, the Commercial Tax Officer of the State of Rajasthan got himself impleaded on the ground that the Department had a prior claim for the recovery of sales tax dues under Section 11-AAAA of the Rajasthan Sales Tax Act, 1954. This provision of law stipulated that notwithstanding anything contrary contained in any law for the time being in force, any amount of tax, penalty, interest and any other sum payable by a dealer or any other person shall be the ‘first charge’ on the property. The State Bank of Bikaner cited Section 100 of the Transfer of Property Act to contend that there was a mortgage in favour of the bank and therefore it would have precedence over the claim of sales tax, which was only by way of a statutory charge. The Supreme Court considered the provisions of Section 11-AAAA and its impact on Section 100 of the Transfer of Property Act, 1882.
The Supreme Court noted that there was a distinction between a mortgage and a charge, one which was pointed out by the Supreme Court in Dattatraya Shanker Mote v Anant Chintaman Datar[vii] case. It observed that the conditions of priority as between the holder of a previous charge and a subsequent simple mortgage are entirely covered by Section 100 of the Transfer of Property Act. After analysis of Section 100 of the Transfer of Property Act, and considering the distinction drawn between a mortgage and charge, the Supreme Court held that the expression “transfer of property” used in Section 100 refers to the transferee of the entire interest in the property. It does not cover the transfer of only an interest in the property by way of a mortgage. As the statute created a first charge, it gave priority to the statutory charge over all other charges on the property including a mortgage and hence the charge operates on the entire property of the dealer including the interest of the mortgagee therein.
The Supreme Court made it clear that the statutory first charge created under section 11-AAA of the Rajasthan Sales Tax Act was created in respect of the ‘entire interest’ of the property. Therefore, the first charge would operate over the full title of the property, which continue with the mortgager. In other words, when a statutory first charge is created on the property, the interest of the mortgage is not excluded from the first charge. The expression ‘first charge’ would cover within its ambit a mortgage also. The Supreme Court finally concluded that the statute created a first charge; it gave priority to the statutory charge over all other charges on the property, including a mortgage. The non- obstante provision contained in Section 11(2) of the EPF Act would, therefore, necessarily override all other provisions of law, including the Transfer of Property Act, 1882.
The Supreme Court further remarked that the priory of dues in the effectuation of the non-obstante clauses contained in the DRT Act and SARFAESI Act could be considered only when there was a specific provision in these legislations ‘creating first charge’ in favour of the banks, financial institutions, and other secured creditors. By way of an example, the Supreme Court cited Section 11 of the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952, Section 14-A of the Employees’ Compensation Act, 1923, Section 74(1) of the Estate Duty Act, 1953, Section 25(2) of the Mines and Minerals (Development and Regulation) Act, 1957, Section 30 of the Gift Tax Act, 1958 under which statutory first charge has been expressly created in respect of the dues. Had the Parliament intended to give priority to the dues of banks, financial institutions and other secured creditors over the first charge created under the other legislations, then provisions similar to those contained in Section 11(2) of the EPF and MP Act would have been incorporated in the SARFAESI and RDDBI Act also.
The interplay between EPF law, Banking Recovery Law and the Insolvency Law
Another point of interest here is that an ‘explanatory clause’ has been added to both Section 26-B of the SARFAESI Act and Section 31-B of the RDDBI Act, 1993. It lays down that on or after the commencement of the Insolvency and Bankruptcy Code, 2016 and in cases where insolvency or bankruptcy proceedings are pending in respect of secured assets of the borrower, priority to secured creditors in payment of debt shall be subject to the provisions of the I & B Code. Therefore, once the Corporate Resolution Insolvency Process is commenced, then the priority question gets shifted to the operational domain of the I & B Code.
The provisions contained in Section 36(4) and Section 155(2) of the I & B Code expressly provides for the exclusion of the assets owned by a third party but are hold by the corporate debtor, from the meaning of ‘liquidation estate.’ In a similar vein, it treats the “provident fund, pension fund, and gratuity funds” due to the workers as a ‘third-party’ asset in possession of the Corporate Debtor. These statutory dues are kept away from the clutches of the liquidation process and are excluded from the meaning of ‘liquidation assets’ or the ‘estate of the bankrupt,’ as the case may be.
The NCLAT, in the case of Regional Provident Fund Commissioner-I, Ahmedabad vs Ramchandra D.Choudhary,[viii] held that no provisions of the EPF & MP Act conflict with any of the provisions of the I & B Code. On the other hand, in terms of Section 36(4)(iii), the ‘provident fund’ and the ‘gratuity fund’ are not the assets of the ‘Corporate Debtor,’ there being specific provisions, the application of Section 238 of the I & B Code does not arise. The NCLAT, New Delhi, therefore, directed the resolution professional to release the full amount of provident fund, including the interest thereon in terms of the provisions of the EPF & MP Act, 1952 immediately, as these dues are not to be included as an asset of the corporate debtor. On a Civil Appeal filed by the Corporate Debtor, the Supreme Court affirmed the NCLAT order. Consequently, it is an accepted legal principle that the Provident Fund contributions take precedence over all the debts and must be paid first.
The observations of the Supreme Court in Maharashtra State Cooperative Bank Limited vs Assistant Provident Fund Commissioner and others[ix] shine sufficient light on the issue.
“We shall now consider the question whether the provision contained in Section 11(2) of the Act operates against other debts like mortgage, pledge, etc. Answer to this question is clearly discernible from the plain language of Section 11. The priority given to the dues of provident fund, etc. in Section 11 is not hedged with any limitation or condition. Rather, a bare reading of the section makes it clear that the amount due is required to be paid in priority to all other debts. Any doubt on the width and scope of Section 11 qua other debts is removed by the use of the expression “all other debts” in both the sub-sections. This would mean that the priority clause enshrined in Section 11 will operate against statutory as well as non-statutory and secured as well as unsecured debts including a mortgage or pledge. Sub-section (2) was designedly inserted in the Act for ensuring that the provident fund dues of the workers are not defeated by prior claims of secured or unsecured creditors. This is the reason why the legislature took care to declare that irrespective of time when a debt is created in respect of the assets of the establishment, the dues payable under the Act would always remain the first charge and shall be paid first out of the assets of the establishment notwithstanding anything contained in any other law for the time being in force. It is, therefore, reasonable to take the view that the statutory first charge created on the assets of the establishment by sub-section (2) of Section 11 and priority given to the payment of any amount due from an employer will operate against all types of debts.“
Thus, a harmonious construction of the provisions contained in Section 11(2) of the EPF & MP Act, 1952, and those set out in other legislations including the SARFAESI Act, RDDBI Act and the I & B Code, 2016, makes it clear that the provident fund dues assume the first charge on the assets of the corporate debtor.
[i] Recovery Officer, EPF v Kerala Financial Corporation [(2002) 3 ILR Kerala 4]
[ii] Special Civil Appeal No.4879 of 2017, decided on 10th April 2017
[iii] Company Application No.271 in Company Petition No.305 of 1999, decided on 21st July 2017, Gujarat HC
[iv] Special Application No.3046 of 2007, decided on 22nd April 2010.
[v] AIR 2012 SC 11
[vi] 1995 (2) SCC 19
[vii] 1974 (2) SCC 799
[viii] Company Appeal No.1001 of 2019
[ix] 2009 (10) SCC 123